Uncertainty Surrounds Tax Planning for 2008, 2009, CCH Says

(RIVERWOODS, ILL., September 18, 2008) – As 2008 heads into the fourth quarter, taxpayers who want to minimize their tax burden for this year and next have a range of options, but also face a considerable amount of uncertainty, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com).

“There are many things the average person can do to lower this year’s taxes,” said Mark Luscombe, JD, CPA, CCH principal federal tax analyst. “But more than most years, many people will have to keep an eye on Washington to see how their returns will be affected. Congress has yet to act on the alternative minimum tax exemption for 2008 and the fate of several popular tax benefits that expired at the end of last year is up in the air. The presidential election adds even more uncertainty.”

Clock is Ticking

As the year winds down, time is growing short for Congress to extend several deductions and credits. Absent new legislation, you cannot take an itemized deduction for state and local sales tax or the q ualified higher education expenses deduction, an “above-the-line” deduction valuable even if you can’t itemize. The ability of educators to take an above-the-line deduction for school supplies expired at the end of 2007, also. Tax credits for many types of energy-saving home improvements ended with the 2007 tax year, although there is a chance they will be extended before year-end.

Also uncertain is how many people will be subject to the alternative minimum tax, or AMT. In 2007, the AMT exemption, which largely determines who falls under the alternative system, was set at $44,350 for single individuals and $66,250 for married couples filing jointly, but this year these amounts reverted to just $33,750 for individuals and $45,000 for married couples filing jointly. Congress is expected to enact another round of temporary relief, but just when that will happen and whether the relief will be enough so that people not previously subject to the alternative tax will continue to escape its clutches is uncertain. The best bet is that the AMT will continue in something like its present form, with exemption amounts a bit higher than the ones in 2007, at least for the 2008 tax year.

Election Year Uncertainties

Complicating tax planning for some people is the uncertainty surrounding the presidential election.

“While Senator McCain seems to want to retain all of the Bush tax cuts past their scheduled expiration in 2011, Senator Obama has indicated a willingness to increase ordinary income and capital gains taxes for wealthy individuals – say, those with more than $250,000 in income – while lowering taxes for people with incomes up to $75,000,” Luscombe noted.

As a result, some wealthier taxpayers may consider selling some appreciated assets and accelerating income into this year, providing that Obama wins the election.

“It is true that a new president will often try to push his tax agenda through Congress in his first year in office, but there can be a long and winding path between proposal and law,” Luscombe observed.

Know Your Bracket

With many key tax provisions uncertain, there are still some general rules that will help many people. Tax planning begins with such simple things as knowing your tax bracket – the percentage at which your top dollar of income will be taxed. Brackets currently range from 10 to 35 percent. The income levels at which the brackets begin and end are adjusted annually for inflation.

As a general rule, it’s better for anyone to pay a tax later than sooner, but in addition, people in higher brackets benefit from the annual indexing of the brackets and other items for inflation, so more of their income will be taxed at lower rates in 2009 than in 2008.

If you’re an employee and are usually paid a year-end bonus, you may be able to make arrangements with your employer to have the bonus paid in and credited to 2009 rather than 2008. If you run your own small business and bill your clients, you might be able to defer income simply by not billing until next year.

Retirees may have an opportunity to lessen their taxes by carefully planning how they take large distributions from IRAs – for example, a distribution to buy a retirement home or pay off credit-card debt.

“By splitting up a large distribution and taking part in December and part in January, you may avoid moving to a higher tax bracket in either year, and keep more of your Social Security benefits from being taxed as well,” Luscombe said.

Making the Most of Deductions

You can exercise control over the timing of deductions, as well as income. If you have a property tax bill for 2008 that’s due in January, you can pay it in December to clinch a deduction on your 2008 return. Similar opportunities may exist with scheduling elective medical procedures or making a charitable contribution.

The question is whether accelerating deductions into the current year is always the best strategy. Sometimes it is and sometimes it isn’t.

“If your itemized deductions are close to the size of your standard deduction, you’re often better off ‘bunching’ deductions in alternate years. That can give you a significant amount of itemized deductions in, say, odd years while you take advantage of the standard deduction in even years,” Luscombe said

Many taxpayers on the line between regular tax and AMT try to time deductible expenses so they avoid the alternative tax, but they won’t know how much to shift around until Congress acts, or fails to act, on this year’s exemption amount.

“If your regular tax and alternative minimum tax are fairly close together, you’re probably better off not bunching deductions, but trying to smooth out the ones that can trigger AMT liability from year to year,” Luscombe suggested.

Housing Act Offers Special Opportunities

There’s a special consideration this year for those whose itemized deductions include state and local property taxes and whose itemized deductions barely exceed the standard deduction. Under a provision of the Housing and Economic Recovery Act of 2008, they can take the standard deduction and then an “additional” standard deduction equal to their property taxes, capped at $500, or $1,000 for joint filers. They then cannot take any itemized deductions. As the law now stands, this extra standard deduction won’t be available in future years.

“If people qualify, they might also look at whether they can move some of their 2008 itemized deductions into 2009,” Luscombe stated. “Then their deductions may be greater when they go back to itemizing – assuming that the one-year opportunity to take property taxes as well as the standard deduction isn’t extended.”

Another short-term tax saving opportunity created by the Housing Act is a first-time home buyer’s credit available to those who purchase a home on or after April 9, 2008 and before July 1, 2009. The credit is 10 percent of the purchase price or $7,500, whichever is less – but for married people filing separately the $7,500 limit becomes $3,750. The credit begins to phase out at the $150,000 income level for joint filers ($75,000 for other filers) and is not available for joint filers with income above $170,000 ($95,000 for other filers).

Those who buy their qualifying home in 2009 have the option of treating the purchase as having taken place on December 31, 2008, allowing them to file an amended return and apply the credit toward their 2008 tax liability, if they wish.

“The one caveat with this provision is that the ‘credit’ is more like a no-interest loan from the IRS that has to be repaid, starting no later than the second year after the purchase,” Luscombe noted. “The IRS can be a strict creditor, and if you fall behind on repayment, you can have an IRS lien on your home.”

Move Before Year-end?

Because of another provision in the Housing Act, people who own a vacation or rental home that they intend to occupy as their principal residence sometime in the future might want to consider making their move this year, Luscombe noted.

“If they make the second home their new principal residence before year-end, they can take advantage of the full home sale exclusion on their current home when they sell it, and also take the full exclusion on the new home if they sell it more than two years down the line,” Luscombe said.

The exclusion amounts to $250,000 for single taxpayers and $500,000 for joint filers. In the future, sellers will have to pro-rate the exclusion between the time that a home was their principal residence and “non-qualifying” use as a vacation or rental property after December 31, 2008.

Retiree, Health Plans Can Lower Next Year’s Taxes

The closing months of the year are often “open enrollment” periods for employee benefit plans that can reduce your taxes for next year, if not this one.

“Paying for health or dependent care expenses on a pre-tax basis and contributing to a 401(k) will directly lower your adjusted gross income for 2009,” Luscombe said. “A lower adjusted gross income, in turn, can qualify you for more deductions and credits that are ‘phased out’ as income rises, as well as lowering your taxes directly.”

Some companies now offer Health Savings Accounts – HSAs – in conjunction with high-deductible health insurance plans. These offer the opportunity to pay for deductibles and co-payments with pre-tax dollars and even to roll over unused HSA dollars to future years.

“There’s a definite chance of saving on taxes with these plans, but there’s also a chance of incurring higher out-of-pocket costs than with traditional plans,” Luscombe observed. “As with many other financial decisions, tax consequences are only one factor to be weighed.”

Tax Savings with IRAs and Keogh Plans

Taxpayers who aren’t covered by an employer’s retirement plan – or who are covered by a plan but whose income falls below certain levels – can cut their taxes by contributing to a traditional, deductible, IRA or, if they are self-employed, to a Keogh plan.

In either case, they have until April 15, 2009 to actually deposit funds in their retirement account, but the Keogh has to be set up by December 31, 2008, for any contribution to be excluded from 2008 income. An IRA doesn’t have to be established until April 15, 2009 for contributions to count against the previous year’s taxes.

“You can use a refund to fund your IRA or Keogh, if you file far enough in advance to have the money in your hands by April 15, 2009,” Luscombe noted.

For seniors required to make withdrawals from their IRAs, the end of 2007 closed a window of opportunity for avoiding taxes on them – unless Congress extends a short-lived tax break. The expired provision allowed a distribution of up to $100,000 that was made directly to a charity to be excluded from income.

“If someone didn’t need the amount that they are required to remove from their IRA, this was an opportunity to avoid a tax ‘hit’ while helping out a favorite cause,” Luscombe noted. “Now, the ability to do this for 2008 distributions is dependent on Congress passing ‘extender’ legislation,” Luscombe added.

A Roth IRA Possibility

High-wealth individuals might consider funding a non-deductible IRA with an eye toward rolling it over into a Roth IRA in 2010. This does not reduce current taxes, but promises tax-free withdrawals from the Roth IRA in future years. In addition, Roth IRAs are not subject to minimum-distribution rules as other IRAs are.

“What’s important here is that high-income individuals are not allowed to establish Roth IRAs or convert from a traditional IRA to a Roth. But tax legislation opened the door to conversions in 2010,” Luscombe said.

The conversion option would be attractive to people who are currently barred from setting up a Roth IRA and who do not have any funds in a traditional, deductible IRA.

“If you have a traditional IRA, you can’t set up a non-deductible IRA and then be taxed as if you had converted only the non-deductible IRA to a Roth IRA,” Luscombe stated. “Whatever amount was converted would be treated as coming proportionally from both IRAs, triggering taxes on the funds deemed to come from the traditional IRA.”

Enjoy Your Tax Savings

As you take steps to lower your tax bill, you should take one more step – to make sure that those savings go straight into your pocket, rather than sitting in the IRS’s coffers until you apply for a refund.

“If you know your tax bill will be lower for any reason, you should take steps to enjoy your lower taxes now or in the future by increasing your take-home pay or your savings. You can invest the money, contribute to one of the many tax-advantaged retirement vehicles available or buy things you need without racking up credit card debt,” Luscombe advised.

“By adjusting your withholding on Form W-4, you can start receiving your 2008 refund this year, and your 2009 refund in January,” Luscombe said.

About CCH, a Wolters Kluwer business

CCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax, accounting and audit information, software and services. It has served tax, accounting and business professionals since 1913. Among its market-leading products are The ProSystem fx® Office, CorpSystem®, CCH® Tax Research NetWork™, Accounting Research Manager® and the U.S. Master Tax Guide®. CCH is based in Riverwoods, Ill.

Wolters Kluwer is a leading global information services and publishing company. The company provides products and services globally for professionals in the health, tax, accounting, corporate, financial services, legal and regulatory sectors. Wolters Kluwer has annual revenues (2007) of €3.4 billion ($4.8 billion), maintains operations in over 33 countries across Europe, North America and Asia Pacific and employs approximately 19,500 people worldwide. Wolters Kluwer is headquartered in Amsterdam, the Netherlands. For more information, visit www.wolterskluwer.com.

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EDITORS’ NOTE: For members of the press, a complimentary copy of CCH's Tax Planning Strategies 2008-2009 is available by contacting Neil Allen at 847-267-2179 or neil.allen@wolterskluwer.com or Brenda Au at 847-267-2046 or brenda.au@wolterskluwer.com.